Income from a timber sale is usually a taxable income event. However, a portion of the investment you made in the timberland may be allocated against this income. Your basis must be allocated between land, timber, and other capital improvements. When you sell your timber, you may be able to take a depletion deduction equal to the adjusted basis divided by the total timber volume multiplied by the timber volume sold. Keeping good records including timber cruises, timber valuations, and scale reports is essential for supporting the depletion allowance.
If timber sale proceeds are reported as ordinary income, you can expect to pay much more in taxes than if you report the income as capital gains. In order to qualify for long-term capital gains you must own the property for more than 12 months. If you have to report the income as ordinary income you may be subject to self-employment taxes as well.
If you have planted seedlings on your property this year (2001) check out the reforestation tax credit and 7 year amortization of the cost of the planting. To take advantage of this tax credit you must file during the year that the reforestation expenses were incurred.
There are certain advantages to being an active participant in a trade or business. If you are treating your tree farm or property as a business, and you are materially participating in the business, you may be able to deduct the expenses. These expenses can include property taxes, interest, and other management expenses. This deduction may be deductible against income from any source.
Cost-share assistance may need to be reported as ordinary income. A certain portion or all of the cost-share may be excluded if certain conditions are met. These condition include:
The IRS must approve the cost share program for exclusion (currently FIP, SIP, WRP, EQIP, WHIP and many State programs are approved for exclusion). And the maximum amount excludable is the present value of $2.50 per acre or the present value of 10% of the average income per acre for the last 3 years whichever is greatest. Often if you have harvested in the past 3 years all cost-share monies are excluded.
Planting in a Conservation Reserve Program field results in the CRP payment being treated as ordinary income. Cost-share for planting is also treated as ordinary income; however, the reforestation tax credit amortization now applies.
Casualty loss must be some event that is identifiable, damaging the property, and sudden or unexpected such as a wildfire. Casualty losses cannot exceed the basis less any insurance or compensation received for the loss. The casualty loss may be limited.
Management and maintenance expenses of your timberland can be expensed or capitalized. Generally, you are better off if you can expense these items. You must be an active participant in the management of your property to qualify.
As a landowner you must keep good records of your activities. There are advantages to being an active participant in the management of your property. See your tax advisor to obtain more information concerning these issues.